The Government has set out its thinking on the future for work pensions where employees are promised a retirement income according to a combination of how long they have worked and their salary (defined benefit schemes).

For those whose future retirement income is dependent upon such an arrangement, it does not make for altogether pleasant reading.

Here, we analyse the key issues raised.

Defined benefit schemes: The Government has set out its thinking on the future for work pensions - and their plans could harm your nest egg

What is the objective of the Government’s Green Paper?

It is concerned the current rules surrounding defined benefit pension schemes are too prescriptive for employers.

It therefore wants to look at ways of encouraging companies which are struggling financially to continue supporting such pension funds – essentially by giving them more leeway over the income they pay pensioners when they retire.

There are around 11 million people who in the future will draw an income from a defined benefit pension fund provided by a company they worked – or still work – for.

Share this article

HOW THIS IS MONEY CAN HELP

Such a company pension promises to provide a retirement income based on a mix of the number of years worked and salary.

For example, someone who retires on a salary of £30,000 and has worked for the same company for 20 years would get a starting annual pension of £10,000 if the pension scheme was set up on a sixtieth of final salary basis – in other words a sixtieth of £30,000 for every year worked.

Some defined benefit schemes do not calculate the starting retirement income on final salary but on a worker’s average over their career.

So what is the Government proposing?

Numerous factors have combined to make defined benefit pension schemes expensive for employers to keep going.

Key is ever-increasing longevity which means they are having to pay pensions for longer.

The result is that in many cases the assets in the pension fund are insufficient to cover all the pensions that must be paid in the future, resulting in employers pumping ever more money into the schemes.

Experts calculate that the collective deficit – the mismatch between assets and liabilities – on defined benefit schemes is £470billion.

To ease the pressure on ‘struggling’ employers, the Government suggests they should be allowed to restrict the annual increases they pay retirees.

Currently, most schemes increase pensions in payment every year in line with the Retail Prices Index, subject to a cap of either 2.5 per cent or 5 per cent dependent upon when the worker contributed. Some are more generous, some less so.

But by allowing distressed companies to apply increases linked to the Consumer Prices Index measure of inflation, the Government says their pension woes would reduce. In nine of the ten years up to 2015, CPI has been lower than RPI.

Good news for businesses, bad news for workers. Pension consultants Hymans Robertson says the financial loss for retirees would be considerable – on average £20,000 over their retirement.

How has this idea gone down?

Steve Webb: Escape routes for employers could lead to staff being 'exploited'

Not particularly well, as expected. Steve Webb, former Pensions Minister and now director of policy at financial services mutual Royal London, believes such an escape route for employers could be ‘exploited’, culminating in ‘millions of people being at risk of cuts in their real living standards’.

His view is echoed by the Trades Union Congress which says the reforms would ‘transfer wealth from pension savers’.

The Work and Pensions Committee, chaired by Frank Field MP, is more sanguine, saying it is an option worth considering if it helps preserve tottering defined benefit schemes and works in the long-term interest of pension savers.

What happens next?

The Government is seeking views between now and the spring.

At some stage a White Paper will follow, but it might take a while.

It would be a surprise if transformative legislation were pushed through before 2020 – the time of the next General Election – especially if political nervousness kicks in.

What about defined benefit schemes in the public sector?

Increases in pension payments for the likes of council workers, teachers, MPs and NHS staff are already linked to CPI.

But unlike private sector workers, their pensions are gold plated, backed by taxpayers.

Private workers always run the risk of their employer going bust in the future leaving in place a pension fund unable to meet all its promises.

They will then receive reduced – and capped – payments from the Pension Protection Fund set up to help in such cases.